Bankers tend to wear narrow ties, and in this economy, they seem narrower than ever before.
Commercial lending is a risk/reward tradeoff, for both the lender and the borrower. From the lender's perspective, loans are provided to what they believe to be eligible, creditworthy small business concerns. Key within that concept is the term "believe", as the process is much like the medieval notion of alchemy: an amalgamation of science and magic. Not only do the numbers need to work, but faith in the borrower's character, the belief in the viability of the business and/or project, and various other intangible elements play roles in the final decision. After all, the first four words of a standard promissory note speak volumes: I promise to pay. Nevertheless, by necessity, the underwriting is strongly slanted toward the scientific aspects of the loan request.
The borrower, on the other hand, is Merlin the Magician, with a Subway Sandwich franchise agreement instead of a magic wand. Although they recognize that the math must make sense, their viewpoint is typically skewed toward the intangibles inherent within the idea or concept: the freedom, the potential, the possibilities. Much like the line from the over-hyped 1989 Kevin Costner flick Field of Dreams, "If you build it, he will come", the small business owner has faith that if they open it, the customer will come — and with that, the business will be successful.
The line between the two components is a fuzzy one, and navigating it is difficult at best even during booming economies. In recessionary times, both sides become significantly more risk averse, and bridging the gap becomes even more problematic.
The Mission of the SBA
The Small Business Administration was created in 1953. After initially offering direct loans, it ultimately evolved into an Agency that guarantees loans made by banks, credit unions, and other lending entities to eligible small business concerns. A central factor within the SBA's mission is in facilitating long-term loans, often much longer than what the private sector is willing to offer. The longer the term, the smaller the monthly payment, making an SBA loan a good choice with respect to minimizing the impact of the payment against available cash flow.
A secondary consideration (but potentially equally as important) is the ability of SBA financing to partially supplement down payment requirements, as well as possibly reducing the need for collateral. Depending upon the program, as well as the lender's interpretation of SBA policy and its own internal lending guidelines, a loan could be made outside of standard commercial lending parameters, provided that the small business concern is determined to be eligible, repayment ability is reasonably assured and the borrower's character is deemed satisfactory.
Eligibility
The SBA looks at three main factors when considering whether or not the small business concern is eligible:
- Size: The Small Business Jobs Act of 2010 expanded the size guidelines applied to the SBA's flagship 7(a) loan program, the most popular of all SBA's lending activities. The 7(a) and 504 loan programs (a low down payment financing option for owner-occupied real estate) can now utilize the same standards: business tangible net worth not to exceed $15 million, and average business net profits not to exceed $5 million over the past two years.
- Uses of Proceeds: The uses of proceeds must be for the direct benefit of the small business concern. Most uses are eligible; for 7(a) loans, the SBA provides a list of eligible and ineligible purposes.
- Personal Resources: Owners of 20% or more of the small business concern must not have excess liquid assets that can be utilized in lieu of the proposed loan. The exempted amounts depend upon the size of the total financing package, but vary between 1-2 times the total project cost.
Typical Uses of Proceeds
A 7(a) loan can be used for working capital, inventory, trade payables, business debt refinance, equipment purchases, acquisition of owner-occupied commercial real estate, business acquisitions, and for other purposes — potentially all within the very same loan. The 7(a) loan is also a very common mechanism to start up a new small business. A 504 loan is generally used for the acquisition of owner-occupied commercial real estate or for significant fixed asset purchases.
Terms
A 7(a) loan is typically amortized between five and twenty-five years, depending upon the uses of proceeds. Short-term purposes (working capital, inventory, payables, most debt refinancing, some equipment purchases) tend to fall within the shorter end of the range, generally capped at seven years. Heavy equipment can be financed over 10-15 years, and owner-occupied commercial real estate is eligible for 25 years.
A 504 loan carries a term of 20 years on the SBA's portion, funded via a debenture facilitated by a Certified Development Company (CDC). The financing also involves a direct loan by a commercial lender in first position against the real estate being acquired. The amortization will typically match the SBA's portion, with a maturity date of no less than ten years.
Interest Rates
Almost all 7(a) loans are priced with variable rates, tied to the Prime rate, with a negotiable margin that ordinarily does not exceed 2.75% over the index.
504 loans carry fixed rates on the SBA debenture portion (40% of the financing) at below-market rates. The first mortgage provided by the conventional lender can be priced on either a fixed or variable-rate basis.
Fees
Fees and costs vary depending upon the size and complexity of the loan. The SBA's fee, whether through 7(a) or 504, is established by the Agency, not the lender. As a general rule of thumb, the fee is in the range of 2-2.5% of the total loan amount.
Turnaround Time
The time required to obtain an SBA loan depends upon how the proceeds are being used, the lender's proficiency and experience in the process, your responsiveness to lender requests for information, and other factors. The SBA Express is a streamlined 7(a) product that allows the lender to utilize most of its own forms and processes, in trade for a lesser guarantee. However, it has significant size limitations. As a rule of thumb, most 7(a) loans should take between two and eight weeks to complete. A 504 loan will normally take the longer end of that range, due to the real estate-intensive nature of the program.
Other SBA Programs
Other SBA programs include Small Rural Lender Advantage, Community Express, Export Express, Patriot Express, International Trade Loan Program, Export Working Capital Program, Standard Asset Based CAPLines, Small Asset Based CAPLines, Contractor Based CAPLines, Seasonal CAPLines, and Builder CAPLines. Contact your local SBA District Office for more information about these programs.
The SBA Bridges the Gap
Lenders are human. They want to make business loans, and they want the small business to succeed. You're human. You want a small business loan, and you want your business to succeed. So what's the problem? Well, the lender's opinion of the likelihood of success going forward may differ from yours, and the terms they may offer can be challenging to your future cash flow. The SBA exists to bridge the gap between what the small business owner wants and what the lender is willing to offer. Now go fit yourself for that magician's hat — in today's topsy-turvy world, you're gonna need it.
Sources
- SOP 50-10-5(c),SBA.gov
Walter McLaughlin - I am a 47-year old commercial banker living in the Seattle area. I am an avid sports fan, but also greatly enjoy writing satirical, ...
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